1. Today’s Topic-- Production and Output

2. Into Outputs Firms Turn Inputs (Factors of Production)

3. WHAT ARE COSTS? The Firm’s Objective –The economic goal of the firm is to maximize profits.

4. Total Revenue, Total Cost, and Profit Total Revenue –The amount a firm receives for the sale of its output. Total Cost –The market value of the inputs a firm uses in production. Profit = Total revenue - Total cost

5. Costs as Opportunity Costs A firm’s cost of production includes all the opportunity costs of making its output of goods and services. Explicit and Implicit Costs –A firm’s cost of production include explicit costs and implicit costs. Explicit costs are input costs that require a direct outlay of money by the firm. Implicit costs are input costs that do not require an outlay of money by the firm.

6. Economic Profit versus Accounting Profit Economists measure a firm’s economic profit as total revenue minus total cost, including both explicit and implicit costs. Accountants measure the accounting profit as the firm’s total revenue minus only the firm’s explicit costs.

7. Economic Profit versus Accounting Profit When total revenue exceeds both explicit and implicit costs, the firm earns economic profit. –Economic profit is smaller than accounting profit.

8. Figure 1 Economic versus Accountants Copyright © 2004 South-Western Revenue Total opportunity costs How an Economist Views a Firm How an Accountant Views a Firm Revenue Economic profit Implicit costs Explicit costs Explicit costs Accounting profit

9. Short Run-- Period long enough to change some, but not all, inputs Long Run-- Period long enough to change all inputs

10. Production Function-- Relationship between inputs and output

11. Production Function  Indicates the output that a firm produces for every specified combination of inputs  Describes what is technically feasible when firm operates efficiently

12. Marginal Product-- The additional output that can be produced by one more unit of a particular input, while holding all other inputs constant  in Q  in variable input MP =

13. AP = Q variable input Average Product The amount of output produced by the typical unit of a particular input, while holding all other inputs constant

14. Law of Diminishing Marginal Returns-- As you combine more and more of the variable input with the same amount of fixed input, eventually the additional output produced will decrease. Short Run

15. Diminishing Marginal Product –Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment. –The slope of the production function measures the marginal product of an input, such as a worker. –When the marginal product declines, the production function becomes flatter.

16. Figure 2 Hungry Helen’s Production Function Copyright © 2004 South-Western Quantity of Output (cookies per hour) 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 Number of Workers Hired 012345 Production function

17. output Variable input TP Diminishing Marginal Returns MP Diminishing Marginal Returns

18. Cost Classifications FIXED COSTS– Costs that stay the same no matter how much output is produced FC Costs that increase with the level of output VC

19. Total Cost = TC TC = FC + VC FC = TC - VC VC = TC - FC Think TOTAL

20. Average Total Cost = ATC ATC = TC AVC = VC AVC = VC Q Q Q ATC = AFC + AVC AFC = ATC – AVC AVC = ATC – AFC Think AVERAGE

21. Marginal Cost = MC MC = Change in TC = Δ TC Change in Q Δ Q The rate at which costs ↑ When Q ↑ Think on the MARGIN

22. From the Production Function to the Total-Cost Curve The firm uses inputs to produce output -the production function The total-cost curve graphically shows the relationship between the amount of output produced by the firm and the cost associated with this production.

23. Table 1 A Production Function and Total Cost: Hungry Helen’s Cookie Factory Copyright©2004 South-Western

24. Figure 2 Hungry Helen’s Production Function Copyright © 2004 South-Western Quantity of Output (cookies per hour) 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 Number of Workers Hired 012345 Production function

25. Figure 3 Hungry Helen’s Total-Cost Curve Copyright © 2004 South-Western Total Cost $80 70 60 50 40 30 20 10 Quantity of Output (cookies per hour) 0102030150130110907050401401201008060 Total-cost curve

26. Cost Curves and Their Shapes Rising marginal cost as the amount of output produced increases reflects the property of diminishing marginal product.